$200 oil?

By Reuters Staff

June 25, 2008

If Israel bombs Iran, $200 oil is a distinct possibility. Both look more likely given recent developments. Consider:

Israel is making oddly accommodating overtures to erstwhile enemies Syria and Hamas. Hamas has been firing rockets non-stop from Gaza into Southern Israel since they drove out Fatah a year ago. Syria had begun constructing a nuclear reactor before the Israelis bombed it last September. Yet in the last two weeks, Israel set a truce with Hamas, revealed secret negotiations with Syria, and even urged the Lebanese to open peace talks. Are the Israelis reaching out to their secondary enemies so that they can concentrate on Iran, their primary strategic foe?

Israel has dialed up its rhetoric too. On June 6th, Israeli cabinet minister and former army chief of staff Shaul Mofaz called an attack on Iranian nuclear sites “unavoidable.” [That was the day oil jumped $10 a barrel, incidentally.]

And most notably, the Israeli Air Force recently rehearsed a potential attack on Iran. The intent was for the World, and the Iranians, to notice.

And that may be all Israel is doing here: reminding the Iranians, and the World, that they are prepared to act if sanctions fail to arrest Iran’s nuclear program. Others believe Israeli action is a foregone conclusion.

Forthwith some predictions in the event Israel attacks…….(plus a nifty chart for those of you who read on)

(Here’s a downloadable copy of the slide above. Should be more legible than the jpeg file above.)

The first consequence of an Israeli (or American) attack would be Iranian retaliation.

Iran’s first option would be to block the Strait of Hormuz, the 21-mile wide shipping lane at the mouth of the Persian Gulf through which 20% of the world’s oil supply flows every day. They could also attack oil production facilities in Kuwait, Saudi Arabia and the UAE. They could cut off their own oil supplies. Last, they could leverage their highly developed terrorist network (Hamas, Hezbollah, et al) to attack oil installations on their behalf.

The above I’m taking from a fantastic paper published this month by Simon Henderson that outlines Iran’s retaliatory options. [Most interesting are all the reasons Iran may NOT want to disrupt oil supplies, primarily because its economy relies heavily on oil exports and gasoline imports.]

So of course the most obvious economic effect of an attack would be (much) higher oil prices. That would drive inflation ever higher, especially in developing nations that spend a greater amount of national income on energy.

But while the jump in oil prices may be significant, it may also be temporary. In the first two months of the Gulf War, oil prices doubled. And yet four months later they had fallen back to pre-war levels. Indeed, if you look at the chart above, you can see that some oil supply shocks haven’t impacted prices. [Here is a spreadsheet with the raw data.] Never before has there been a supply disruption of the magnitude Iran is threatening, however, which is why I’d bet oil prices leap substantially. My point is simply that any price spike may be short-lived.

To the extent they could, other Middle Eastern nations would have strong incentives to vastly increase supply. First of all, they’re as anxious as Israel about the Iranians acquiring nukes. Indicative of this fact was the total silence from ALL Arab countries following the Israeli bombing of the Syrian reactor. Syria is aligned with Iran, remember. Many are quietly hoping Israel takes out Iranian nuclear facilities.

Second of all, if oil gets too expensive, we may shake a meaningful chunk of our oil addiction. The Arabs certainly don’t want that to happen.

It is perhaps worth noting that over the weekend the Saudis said they would pump more oil, which seemed an odd and sudden reversal. Only a month ago, they rejected George Bush’s in-person plea for more supply.

Would an attack actually disrupt Iran’s nuclear capabilities? Yes, probably. Though the Iranians learned from the Israeli attack on Iraq’s Osirak reactor in 1981—burying much of their nuclear program below reinforced concrete that is harder to bomb—the Israelis have vastly improved their military capabilities, acquiring GPS-guided bunker buster bombs that can penetrate reinforced concrete. A fantastic paper by Whitney Raas and Austin Long from International Security describing Israel’s strategic options is available here.

Should the Israelis attack? That is more complicated. The total success of the Osirak raid is encouraging at first glance. And yet Saddam eventually redoubled his nuclear efforts and would likely have acquired nukes had it not been for the IAEA. At best, an Israeli raid could severely retard Iran’s efforts; Iran could rebuild.